Can a state file for bankruptcy?

We all know what bankruptcy is intended for, to help people or companies get back on their feet financially by eliminating burdensome debts. The aim is to essentially wipe the slate clean and, by doing so, give hope for the future. When it comes to individuals and corporations, though it can be hard to finally take the step of filing, it’s good to know that the right to do so always (or almost always) exists. For other entities, particularly states, the debate isn’t about when to file, but whether filing is even legally possible.

A good example of this trouble is Illinois. The state is a mess, financially speaking, and there doesn’t seem to be much hope for the future. It’s been 720 days since the state had a budget in place, leading to billions and billions of unpaid bills that have piled up. Powerball has said that it may exclude Illinois from its lottery given the precarious budgetary situation. State officials have said that all transportation and roadwork will stop as of July 1, given the lack of budget to continue paying contractors. Even state employees may not be able to be paid given the lack of revenues into state coffers.

Beyond these mounting bills, the state is overwhelmed with pension liabilities (one expert estimates the pension liabilities alone are equivalent to $27,000 in debt for each resident of the state). The state is also losing citizens and thus its tax base, making it harder and harder to address the many problems it is facing. All these issues are coupled with a dysfunctional state government, a legislature that won’t work with the governor and vice versa.

The problems spell trouble for Illinois, so much so that many have begun to wonder if bankruptcy is around the corner. Though this might seem like an easy choice were Illinois a large company or even a city, like Detroit, the issue is far from clear given Illinois’ statehood. So far, no American state has ever filed for bankruptcy protection of any kind. Though Puerto Rico recently sought an equivalent to bankruptcy relief, they’re an American territory (the first to ever pursue bankruptcy protection), not a state.

There are a few issues with filing for bankruptcy as a state, beyond the fact that it’s never been done before. First, the law is currently not structured in such a way that states could legally file. The federal bankruptcy code doesn’t contemplate a state having to file and the code would have to be amended. This means that Congress would have to pass a law specifically inserting language into the bankruptcy code authorizing states to file for protection. The president would then need to sign the law for it to be effective. At that point, filing as a state would at least be possible.

Though possible, a successful bankruptcy filing would hardly be assured. The next problem Illinois would need to contend with is a constitutional one. Article 1, Section 10 of the U.S. Constitution says that states are specifically prohibited from taking action that would impair contracts. Though the wording is somewhat vague and confusing, many experts believe it is enough to give opponents ground to challenge the bankruptcy in court. The argument would be that filing for bankruptcy does indeed impair contracts, contracts associated with things like pension funds or bonds issued by the state.

Even if Illinois were to receive legal permission to file for bankruptcy, it would have a long fight ahead of it in court. Most believe the Supreme Court would ultimately need to decide the issue, with creditors fighting tooth and nail to prevent the state from getting out from under some of its obligations. Given the extensive fight that would be required, many believe it might actually be easier to take steps to clean up the budget, like raising taxes and cutting government programs. Given the political infighting in Illinois, that remains a rather large hurdle to clear.

If you are contemplating bankruptcy in the Charlotte area, please call the skilled lawyers at Arnold & Smith, PLLC find additional resources here. As professionals who are experienced at handling all kinds of bankruptcy matters, our attorneys will provide you with legally sound advice for your particular situation.